The economics of British rail privatization: an assessment

The economics of British rail privatization: an assessment

The economics of British rail privatization: an assessment

The 1993 Railways Act proposes the re?organization, privatization and deregulation of the rail industry in Great Britain. The economic case for these reforms has recently been put forward in an important paper by Sir Christopher Foster. In this paper, we assess the economics of rail privatization and identify four potential problem areas. Firstly, it is not clear whether the structural reforms being undertaken are appropriate for an industry of rail's technological complexity nor whether a system of negotiated contracts will lead to lower transactions costs than a system of administered commands. Secondly, the vertical separation of infrastructure and operations ignores the likelihood of economies of integration at strategic (investment planning, land?use planning), tactical (maintenance planning) and operational (planning to deal with infrastructure and vehicle failure) levels. Furthermore, there are practical problems in determining infrastructure costs and hence price and of regulating the infrastructure monopoly. Thirdly, there is only limited economic evidence to justify the horizontal separation of rail operations into 30 plus firms. There is some empirical and practical evidence suggesting that there may be diseconomies of scope from jointly operating freight and passenger services and that unbundling these services may be sensible. Similarly, there is some empirical evidence to suggest that, in purely cost terms, British Rail's operations may be too large. However, the evidence suggests that a split into three or four operators would be more efficient than the 30 plus that is being proposed. Fourthly, there are a number of areas of concern over franchising. These include that bidding may not be competitive, that even if there is competition the winning bid may not be efficient and that contracts will be difficult to specify, award, enforce and renew. Where franchising is not exclusive, it is likely that franchises will require a substantial risk premium. We agree that there is a case for continued reform of the British railway industry. Foster argues that the current reforms will lead to an increase in both productive and allocative efficiency and hence a net gain to society. Although we agree that productive efficiency gains are likely, we think that allocative efficiency gains are more problematic. Overall, we believe the economic evidence favours a more cautious approach to railway reform.

Abstract

The 1993 Railways Act proposes the re?organization, privatization and deregulation of the rail industry in Great Britain. The economic case for these reforms has recently been put forward in an important paper by Sir Christopher Foster. In this paper, we assess the economics of rail privatization and identify four potential problem areas. Firstly, it is not clear whether the structural reforms being undertaken are appropriate for an industry of rail's technological complexity nor whether a system of negotiated contracts will lead to lower transactions costs than a system of administered commands. Secondly, the vertical separation of infrastructure and operations ignores the likelihood of economies of integration at strategic (investment planning, land?use planning), tactical (maintenance planning) and operational (planning to deal with infrastructure and vehicle failure) levels. Furthermore, there are practical problems in determining infrastructure costs and hence price and of regulating the infrastructure monopoly. Thirdly, there is only limited economic evidence to justify the horizontal separation of rail operations into 30 plus firms. There is some empirical and practical evidence suggesting that there may be diseconomies of scope from jointly operating freight and passenger services and that unbundling these services may be sensible. Similarly, there is some empirical evidence to suggest that, in purely cost terms, British Rail's operations may be too large. However, the evidence suggests that a split into three or four operators would be more efficient than the 30 plus that is being proposed. Fourthly, there are a number of areas of concern over franchising. These include that bidding may not be competitive, that even if there is competition the winning bid may not be efficient and that contracts will be difficult to specify, award, enforce and renew. Where franchising is not exclusive, it is likely that franchises will require a substantial risk premium. We agree that there is a case for continued reform of the British railway industry. Foster argues that the current reforms will lead to an increase in both productive and allocative efficiency and hence a net gain to society. Although we agree that productive efficiency gains are likely, we think that allocative efficiency gains are more problematic. Overall, we believe the economic evidence favours a more cautious approach to railway reform.